BILL ANALYSIS                                                                                                                                                                                                    



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          ASSEMBLY THIRD READING
          AJR 12 (Block)
          As Amended  June 3, 2009
          Majority vote 

           REVENUE & TAXATION  6-3                                         
           
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          |Ayes:|Charles Calderon, Beall,  |     |                          |
          |     |Coto, Ma, Portantino,     |     |                          |
          |     |Saldana                   |     |                          |
          |     |                          |     |                          |
          |-----+--------------------------+-----+--------------------------|
          |Nays:|DeVore, Harkey, Hagman    |     |                          |
          |     |                          |     |                          |
           ----------------------------------------------------------------- 
           SUMMARY  :  Requests that the United States (U.S.) President and  
          Congress enact legislation that closes the corporate federal tax  
          loopholes relating to tax haven countries.  Specifically,  this  
          bill  : 

          1)States all of the following legislative findings and  
            declarations:

             a)   In bad economic times, states are forced to cut  
               essential services or raise taxes in order to balance their  
               budgets; and, recapturing lost revenues otherwise due to a  
               state is one mechanism by which government can reduce  
               painful cuts without raising new taxes.

             b)   A U.S. corporation is taxed on all of its income,  
               regardless of source, and is allowed a credit for any taxes  
               paid to a foreign country.  A U.S. corporation can operate  
               globally in foreign countries directly through a branch or  
               indirectly through its ownership in a foreign subsidiary. 

             c)   The Organization for Economic Cooperation and  
               Development prepared reports identifying tax haven  
               countries and financial privacy jurisdictions. 

             d)   The U.S. Department of Treasury has found that some U.S.  
               corporations have aggressively moved income to offshore  
               jurisdictions to avoid U.S. taxes and the U.S. Senate  
               Permanent Subcommittee on Investigations released findings  








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               regarding the growth of multinational corporations' use of  
               tax haven countries to shelter income.

             e)   President Obama has voiced his support for efforts to  
               combat offshore tax evasion and the U.S. Commissioner of  
               the Internal Revenue Service (IRS) stated that it is a top  
               priority for the IRS. 

             f)   U.S. Senator Carl Levin introduced the Stop Tax Haven  
               Abuse Act on March 2, 2009, to target offshore tax abuses  
               that deny the U.S. Treasury an estimated $100 billion in  
               revenue each year.

             g)   Some states have enacted legislation to include the  
               income and apportionment factors of affiliated corporations  
               doing business in, or having income derived from, or  
               attributed to, a tax haven country. 

             h)   California permits corporations that conduct business in  
               this state to elect to calculate their state corporate tax  
               liability based on income only from sources within the U.S.  


             i)   As identified by federal officials, corporations are  
               known to redirect income to foreign subsidiaries located in  
               offshore tax haven countries to hide those corporations'  
               true income and to avoid paying their fair share of state  
               tax.  The Franchise Tax Board (FTB) estimates that  
               California incurs an annual revenue loss of approximately  
               $130 million due to corporations' sheltering income in tax  
               haven countries.

          2)Respectfully requests the U.S. President and Congress to enact  
            legislation that would close the corporate federal tax  
            loopholes currently allowing the sheltering of income in  
            offshore tax haven countries and would, instead, promote  
            transparency, cooperation, and tax compliance.

          3)Requires the Chief Clerk of the Assembly to transmit copies of  
            this resolution to the President and the Vice President of the  
            U. S., to the Speaker of the House of Representatives, to the  
            Majority Leader of the Senate, and to each Senator and  
            Representative from California in the U.S. Congress. 









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           FISCAL EFFECT  :   Unknown but probably none. 

           COMMENTS :   The author states that "California corporations are  
          stashing millions of dollars in overseas tax haven countries,  
          and are avoiding paying their fair share of taxes to the state  
          through code loopholes.  President Obama and the U.S. Congress  
          have hinted they would like to close these loopholes at the  
          federal level, in which case California would benefit as well.   
          I applaud their efforts and hope the California Legislature can  
          join me by passing AJR 12, which will encourage the federal  
          government to act to solve the tax haven abuse loopholes."

          What is the problem with incorporating a subsidiary in a tax  
          haven country?  Some corporations and individuals use tax havens  
          to avoid payment of U.S. taxes.  Generally, a tax haven is a  
          foreign jurisdiction that maintains corporate, bank, and tax  
          secrecy laws and industry practices that make it very difficult  
          for other countries to find out whether their citizens are using  
          the tax haven to avoid paying their taxes.  (Statement of  
          Senator Carl Levin on Introducing The Stop Tax Haven Abuse Act,  
          Tax Analyst, December 2009, p. 4).  Data released by the  
          Commerce Department indicates that, as of 2001, almost half of  
          all foreign profits of U.S. corporations were in tax havens.   
          Further, a study released by Tax Notes, September 2004, found  
          that American companies were able to shift $149 billion of  
          profits to 18 tax haven countries in 2002, up 68% from $88  
          billion in 1999.  In January 2009, a report issued by the  
          Government Accounting Office (GAO) shows that out of the 100  
          largest U.S. publicly traded corporations, 83 have subsidiaries  
          in tax havens.  For example, Morgan Stanley has 273, Citigroup  
          has 427, and Oracle has 77 tax haven subsidiaries. 

          U.S. Senator Levin, in his statement, gives a simplified example  
          of how U.S. corporations may transfer taxable income from the  
          U.S. to tax havens to escape taxation.  He states that, "Suppose  
          a profitable U.S. corporation establishes a shell corporation in  
          a tax haven. The shell corporation has no office or employees,  
          just a mailbox address.  The U.S. parent transfers a valuable  
          patent to the shell corporation? [and then] begin to pay a hefty  
          fee to the shell corporation for use of the patent, reducing its  
          U.S. income through deducting the patent fees and thus shifting  
          taxable income out of the United States to the shell  
          corporation.  The shell corporation declares a portion of the  
          fees as profit, but pays no U.S. tax since it is a tax haven  








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          resident."  In addition, the shell corporation may lend its  
          funds to the U.S. parent that, in turn, will pay interest on the  
          loan to the shell corporation, shifting more taxable income out  
          of the U.S. to the tax haven.  Often, those subsidiaries of U.S.  
          companies are shell corporations that are engaged in no or very  
          little business activity.  (Id, at p. 6) 

          Under existing California law, income and apportionment factors  
          of those subsidiaries located in tax haven countries are not  
          included in the water's-edge return of the parent company,  
          unless the subsidiaries are certain affiliated entities such as,  
          for example, an export trade corporation, a domestic  
          international sales corporation, a foreign sales corporation, or  
          a controlled-foreign corporation with Subpart F income.   
          Consequently, companies that manage to shift some of its income  
          to their subsidiaries in tax haven countries will pay less tax  
          to California. 

          Proposed federal legislation:  Section 103 of the Stop Tax Haven  
          Abuse Act would deny tax benefits for foreign corporations  
          managed and controlled in the United States.  It focuses on the  
          situation where a corporation is incorporated in a tax haven as  
          a mere shell operation with little or no physical presence or  
          employees in the jurisdiction.  The impetus for this legislation  
          came from a hearing held by the U.S. Senate Finance Committee in  
          July 2008.  The Committee considered the findings made by GAO  
          with regard to the infamous Ugland House, a five-story building  
          that is located in the Cayman Islands and is the official  
          address for over 18,800 registered companies.  GAO determined  
          that about half of the alleged Ugland House tenants have a  
          billing address in the United States and were not actual  
          occupants of the building.  In fact, GAO found that none of the  
          nearly 19,000 companies registered at the Ugland House was an  
          actual occupant.  The only occupant of that building was a  
          Cayman law firm that established and registered those companies.  


          Section 103 of the Stop Tax Haven Abuse Act states that, if a  
          corporation is publicly traded or has aggregate gross assets of  
          $50 million or more, and its management and control occurs  
          primarily within the United States, then that corporation will  
          be treated as a U.S. domestic corporation for income tax  
          purposes.  Section 103 provides an exception for foreign  
          corporation with U.S. parents but makes clear that mere  








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          existence of a U.S. parent corporation is not sufficient to  
          shield a foreign corporation from being treated as a domestic  
          corporation.  According to U.S. Senator Levin, the proposed  
          federal legislation "would put an end to the unfair situation  
          where some U.S.-based companies pay their fair share of taxes,  
          while others who set up a shell corporation in a tax haven are  
          able to defer or escape taxation, despite the fact that their  
          foreign status is nothing more than a paper fiction." (Statement  
          of Senator Carl Levin on Introducing The Stop Tax Haven Abuse  
          Act, Tax Analyst, December 2009, p. 13).  

          How would California benefit from the proposed federal  
          legislation?  If the Stop Tax Haven Abuse Act is enacted into  
          law, it will change taxpayers' behavior and, presumably, put an  
          end to financial gimmicks used by certain corporate taxpayers to  
          avoid or minimize their U.S. taxes.  Most likely, California  
          would indirectly benefit from that change in the taxpayers'  
          behavior.  It is unclear, however, and depends on the specific  
          federal act, whether California would need to conform to the new  
          federal law to see an actual increase in state tax collection.

          Similar legislation:  AB 1178 (Block), introduced in this  
          legislative session, would require multinational corporations  
          that elect to file tax returns based only on income earned  
          inside the U.S., known as the water's-edge method, to include  
          the entire income and apportionment factors of any related  
          corporation doing business in or having income derived from or  
          attributable to a tax haven.  

          AB 34 (Ruskin), introduced in the 2005-06 legislative session,  
          was nearly identical to AB 1178 and would have required  
          taxpayers filing on a water's-edge basis to include the income  
          and apportionment factors of affiliated corporations doing  
          business in, or having income derived from or attributable to, a  
          tax haven.  AB 34 failed to pass out of the Assembly.  

          AB 441 (Chu), introduced in the 2005-06 legislative session,  
          would have required a corporation that makes a water's-edge  
          election to include the income and apportionment factors of  
          certain foreign affiliates.  AB 441 failed to pass out of the  
          Assembly. 

          SB 663 (Migden), Chapter 22, Statutes of 2006, clarified  
          specific provisions of the franchise tax law relating to  








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          water's-edge taxpayer and reformed the water's-edge procedure by  
          replacing existing rules creating a contract between the  
          taxpayer and FTB with election procedures. 


           Analysis Prepared by  :  Oksana Jaffe / REV. & TAX. / (916)  
          319-2098 




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